What is an engulfing candlestick and how can you use it in your trading strategy? There are two types: the bullish engulfing, and the bearish engulfing candle. A bullish engulfing candle can indicate a change in momentum to the upside. The opposite is true for a bearish engulfing candle. The pattern is made up of 2 candlesticks, where the most recent candle's body fully engulfs the body of the previous candle.
Here's What They Look Like
NOTE: Keep in mind that with engulfing candles, we are not concerned with the wicks of the candles. As long as the body engulfs the previous body, it is considered an engulfing candle. However, it may be even stronger of a candle if it engulfs the wicks too.
How to Trade This Candlestick Pattern
Engulfing candles usually show up at the end of a trend to signal a reversal. The way we like to trade them is to spot them in short term counter-trends, in anticipation of a continuation of the overall trend.
So, what do we mean by this? Essentially, if a stock is in an uptrend, at one point it is bound to dip to a support level and then continue higher. We look for the short-term dip followed by an bullish engulfing candle to signal that the longer term trend is about to resume. If we're short selling, then we look for a bounce in price followed by a bearish engulfing candle which will signal more bearishness.
Examples of this below:
Engulfing candles can also be used as an indicator to get you out of a position that you are in. If you look at Macy's chart (posted right above this paragraph), you'll see the large bearish engulfing candle pointed out. If you were in a long position prior, then that candle would surely signal you to close your position. Engulfing candles are even more powerful if they are accompanied by high relative volume on that day.
Where to Place Stop Losses
Generally, you should have your stop a bit under the bullish engulfing candle if you are long and vice versa if you are short selling. You can also put your stop loss under the swing low (if you're long) or the swing high (if you're short).
Example of this below:
Identifying Support/Resistance Spots
Support and resistance levels can be found using moving averages, horizontal supports, and trend lines. The moving averages we use are the 9 EMA, 20 EMA, and 50 SMA. An engulfing candle at the moving averages is a good entry assuming it is in the same direction of the overall trend. Learn more about one of the ways we use moving averages with this swing trading strategy. You can also read our moving average article.
What if The Engulfing Candle is Very Large?
When we take engulfing candle trades on the daily chart, we usually wait until the end of day or right before the closing bell to enter a trade. The reason we do this is to ensure the candle actually closes as an engulfing candle (you don't have to do this, but it decreases chances of getting faked out, although at the expense of a higher entry price).
Because of this, there are cases where an engulfing candle is just huge by the time the candle closes. This may make the risk to reward not in your favor as you would be buying in at too high of a price.
Let's say a stock has a huge engulfing candle and closes at $20/share. Your hypothetical price target based on the chart is $25, but you decide that the most reasonable stop loss is at $13/share. In this case, because of the large candle, your stop loss is wider than your target price, which may make this not an ideal trade (at least not for us).
In this situation, you can buy on a dip on the next candle if there is one, which sometimes happens. If the dip is good enough to make the risk/reward worth it, take the trade. You can also look for a red to green move the next day if you're using daily charts and use the low of the red to green move as your stop loss. Read about red to green moves here.
Here's an example of an engulfing setup that dipped the next day. The engulfing candle is marked by the black arrow, but we actually bought it the next day on the dip to reduce our risk, and we put our stop loss under the swing low (under $110). The trade is yet to play out but that's how we entered it.
We tweeted about the engulfing candle setup the day it happened (see below). But we mentioned our intention of buying on the dip, and thankfully, we got what we wanted.
Where to Take Profits
We won't go into too much depth here as there are many ways to set price targets, but your target with this strategy is generally going to be the high (if you're long) or low (if you're short) of the previous swing, or you can take profits when new highs/lows are made. You can also draw trend lines or horizontal support/resistance points and take profits there, or use a trailing stop loss.
How to Find Engulfing Candle Setups
Thankfully, with TrendSpider it's easy to find these setups. And we're not just saying that because we're affiliated with them, we actually use it! You can search for engulfing candles on multiple time frames and combine them with other indicators as well, such as moving averages, RSI, or whatever you like.
Below is a picture of a quick bullish engulfing candle screener we made on the daily time frame. The screener then populates tickers that fit the criteria on the right side of the screen
That's as simple as a screener can get, and it takes about a minute to set up the first time, which you can then save as a preset screener for future use. You can also make it much more complex, but for the sake of the example we kept it as simple as possible.
In addition, you can set TrendSpider to highlight engulfing candles or any candlestick patterns of your choice on your chart! This makes it way easier to spot them. See the automatically highlighted engulfing candles below.
Need Chart Software?
As we mentioned above, TrendSpider is a top-tier charting platform where traders can put their technical analysis skills to work. It offers automated technical analysis tools, dynamic price alerts, back testing, 1-on-1 training sessions for those who need extra help, and more. A very unique tool that TrendSpider has is Raindrop Charts, which can give you a great edge with your trading.
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Another great charting platform that we would recommend for serious traders is TradingView. We use often as it has many useful tools and is very customizable. There is also an active trading community where people from all over the world post their trade ideas, so you never run out of ideas.